Risk-based reference pool capital reducing systems and methods

ABSTRACT

Embodiments consistent with the present invention provide a credit enhancement structure for risk allocation between parties that minimizes the regulatory capital reserve requirement impact to an institution subject to capital reserve requirement. A subject pool of assets held by the institution, such as a pool of loans, is rated to determine its risk levels. Based on the rated risk levels, a guarantor party agrees to be responsible for a portion of the risk associated with the pool of assets, which may define the maximum risk exposure of the institution holding the asset pool. The risk-rated capital reserve requirements are applied to the asset pool based on the risk level rating and the guarantor&#39;s agreed upon risk responsibility such that the institution holds a reduced amount of reserve capital compared to what it would otherwise be required to hold.

RELATED APPLICATION DATA

This application is a continuation-in-part (CIP) of application Ser. No.10/096,584, filed Mar. 14, 2002 now U.S. Pat. No. 7,099,843, which is aCIP of application Ser. No. 09/602,254, filed Jun. 23, 2000 now U.S.Pat. No. 7,028,007, which is related to and claims priority ofProvisional Application No. 60/151,071, filed Aug. 27, 1999, in thenames of Steven W. Abrahams and Henry J. Cassidy, and entitled GuaranteeCertificates.

BACKGROUND OF THE INVENTION

A. Field of the Invention

The present invention generally relates to financial instruments, andsystems and methods for issuing and administering the same. Moreparticularly, the invention relates to systems and methods forseparating certain payment rights associated with a pool of assets(which may or may not be securitized) from the remaining payment rightsassociated with the pool, such that the separated payment obligationsform separately transferable financial instruments. GuaranteeCertificates evidence an obligation of a mortgage insurer or asecurities guarantor to make payments triggered by certain events,typically, default-related events involving a corresponding (in the caseof a mortgage insurer) or an underlying (in the case of a securitiesguarantor) mortgage loan or loans.

The present invention also relates to systems and methods for hedgingrisk of loss on financial investments. The financial investments mayinclude a pool of assets (which may or may not be securitized).

This invention also relates to risk-allocation structures for a pool ofassets, and more particularly to risk-sharing structures for reducingthe capital reserve requirement of at least one of the parties having aninterest in the pool.

B. Description of the Related Art

Mortgage insurers regularly write contracts that cover the actual orestimated losses associated with the delinquency and default of mortgageloans. In the absence of mortgage insurance, when a mortgage loanbecomes delinquent, the holder of the note typically loses interestpayments it would otherwise have received and also may incur expensesassociated with foreclosure and liquidation of the mortgaged property.The proceeds from liquidation also may fall short of the amount ofprincipal due to the note holder. If, in lieu of a foreclosure, themortgage loan is renegotiated in connection with the default, the noteholder also may experience losses associated with the workout of theloan. In any case, mortgage insurance would reimburse the note holderfor all or part of the foregone interest, expenses and liquidationshortfall.

In the case of loans that have been securitized, i.e., turned into asecurity, mortgage-backed security investors may turn to bond insurersor government-sponsored enterprises to mitigate losses arising fromdefault of the underlying mortgage loans. These parties typicallyguarantee the timely payment of loan principal, interest or both. Inexchange for a fee, these guarantors absorb all or a portion of thelosses that would otherwise be associated with the guaranteedsecurities. When a securitized mortgage loan experiences a paymentdefault, the guarantor typically compensates the security holder for thedifference between scheduled principal and interest payments and theaggregate net amount which is actually realized from a workout orliquidation. As is the case with payments from mortgage insurers, this“make-whole” payment is passed along to a security holderundistinguished from the payment of interest and return of loanprincipal through normal means, such as amortization or prepayment.

In addition, the guarantor generally ensures that these payments aremade to the securities investor at the originally scheduled time, sothat the investor does not bear the risk or expense of delays inherentin the loan workout or foreclosure/liquidation process. The existence ofinsurance for a mortgage loan, or of a guarantee for a mortgage-backedsecurity, is generally established at the beginning of the life of theloan or security in question. A contract between the insurer/guarantorand the investor or trustee sets the terms of the arrangement. A featureof this contract is that the payment obligation of the insurer orguarantor always runs to the owner of the insured or guaranteed asset sothat the asset and the insurance cannot be decoupled, even if the valueof the arrangement to the owner changes. This feature makes thearrangement illiquid and potentially less valuable.

Investors who purchase pools of mortgage loans typically collect a greatdeal of information about the loans in order to assess the riskassociated with the investment. For example, an investor might want toknow the borrower's income, credit score and other financialobligations, as well as the assessed value of the property and the loanto value ratio. Based on this information, the investor canstatistically evaluate the probability that the loans in the pool willdefault and thereby determine the price he or she is willing to pay forthe pool of loans. However, if some or all of the desired information isunavailable, the pool is an undesirable investment. In particular, aninvestor may be reluctant to purchase such a pool or may be willing onlyto pay a low price for it. And although an investor may attempt to hedgethe risk of loss on such a pool, available hedging techniques do notaccurately reflect the probability that the loans in the pool willdefault.

Insurance and hedges are generally available for the typical,well-understood risks associated with common assets and investments. Forexample, the common stock of a company has associated market risk, i.e.,the risk that the stock price will drop due to an overall drop in thestock market, independent of the actions of the company or itsprospects. One way an investor in common stock can hedge against marketrisk is by acquiring positions in a market-index-based security thatwill increase in value if the market index drops in value, such as puts(i.e., a short sale) on a SPYDER (a security that is designed to performin the same way as the Standard & Poor's 500 index).

Risks that are unknown, new, or uncommon are difficult to hedge againstbecause they are not understood well enough for the market to offerhedging products at a reasonable price. For example, lenders, such asbanks, typically originate loans according to industry guidelines, whichare often set out by the entities that subsequently take an interest inthe loans from the originators, such as a subsequent purchaser, insurer,guarantor, or securitizer. Freddie Mac, Fannie Mae, and mortgageinsurance companies are examples of such entities in the case of homemortgage loans. For any given class of loan, the guidelines typicallyspecify, among other things, the minimum borrower credit ratings andFair, Isaac and Company (FICO) scores, borrower income, borrower assets,the amount and type of documentation required to verify the informationsupplied by the borrower, the type of collateral required, the minimumloan to value ratio, etc. If a lender originates a loan using a processor parameters that vary from the guidelines, then an entity thatnormally would take an interest in the loan, such as a loan guarantor,may balk at doing so because it is uncomfortable with, does notunderstand, and does not know how to price the unknown risk associatedwith the lender's variance from the guidelines.

Accordingly, unknown, new, uncommon, or not-well-understood risksassociated with an asset pose a problem if not separated or isolatedsuch that the remaining well-understood risk can be insured, guaranteed,or hedged against in the marketplace. One solution, a reference poolstructure, as described in U.S. patent application Ser. No. 10/096,584,is effective in isolating and limiting such unknown risks for a group ofassets. A reference pool solution, however, may result indisadvantageous capital reserve requirements for capital regulatedinstitutions, such as banks, bank holding companies, thrifts and otherlenders and depositories that are subject to regulation by state andfederal regulatory agencies, such as the Office of the Comptroller ofthe Currency (OCC), the Office of Thrift Supervision (OTS), and theFederal Deposit Insurance. Corporation (FDIC).

Regulated banks are required by federal and state regulations to hold aspecified amount of capital in reserve (“reserve capital”) against thetotal assets they have on their balance sheet. Typically, the reservecapital is simply the mathematical difference between the institution'sassets and its liabilities. In the past under previous regulations, thecapital reserve requirement for the total assets held by a bank wassimple to calculate. The regulations called for a flat ratio of reservecapital to balance sheet assets, calculated by multiplying the value ofall assets held by a bank by a fixed percentage. For example, if a bankheld $500 in assets, the old regulations required the bank holding theseassets to have $500×6%=$30 as reserve capital against the assets. Underthe flat ratio capital reserve requirements, the identity orcharacteristics of the balance sheet assets did not matter. Thus,regardless of whether the assets were $500 of almost risk-free U.S.Treasury bonds or $500 of risky commercial loans, the capital reserverequirement was the same $30.

Over time, the capital reserve requirements evolved from a flat ratio toratios based on asset type. Under the asset-type capital reserverequirements, each specified type of asset held by a capital-regulatedinstitution had a specific capital reserve requirement associated withit. For example, if a bank held a mortgage loan in its portfolio, theasset-type capital reserve requirements required it to hold 4% reservecapital against loan-type assets, which meant that it could not fundmore than 96% of the loan with debt. The regulators required the bank tohave 4% reserve capital set aside to absorb losses on the loan thatmight occur. Thus, if the bank held a $100,000 mortgage on its books, itwas required to have at least $4,000 of reserve capital to back up theloan.

While the asset-type capital reserve requirement is more reflective ofrisk than the flat ratio capital reserve requirement, it still hasinequities. For example, under the asset-type capital reserverequirement, a bank holding $500 in high-quality commercial loans, whichhave a low risk of losing value, has the same capital reserverequirement as a bank holding $500 in low-quality commercial loans thathave a significantly higher risk of default. By not fully consideringthe risk involved, the asset-type capital reserve requirements fail tofully reflect market conditions associated with the assets.

Some regulatory agencies are now moving to risk-based ratio capitalreserve requirements, which are a more ratings-based, risk-weightedapproach for determining the capital reserve requirements for acapital-regulated institution. The regulatory agencies are recognizingthat credit risk ratings, as conventionally used in the public bondmarkets, for example, are useful for fairly determining capital reserverequirements for certain bank-held assets, such as rated bonds. Forexample, a AAA-rated bond is less risky than a BB-rated bond. Regulatoryagencies have begun to tier capital reserve requirements based on arisk-weighted approach such that, for example, banks are required tohold less reserve capital for low risk rated securities than for highrisk rated securities. Thus, some regulatory agencies recognize thatAAA-rated corporate bonds held by a bank are less risky, and thereforerequire less reserve capital to cover losses, than BB-rated corporatebonds.

FIG. 9 illustrates two examples of different types of capital reserverequirements. Table 900 illustrates an example of risk-based capitalreserve requirements. As shown, the Regulatory Rating Category column910 specifies four exemplary asset rating categories: a Cash Equivalentscategory in row 950 (which includes U.S. Treasury bonds), a AAA/AA/MBScategory in row 960 (which includes AAA- to AA-rated securities andmortgage-backed securities issued by government-sponsored enterprises(GSEs) such as Freddie Mac and Fannie Mae), an A to BBB category in row970 (which includes A- to BBB-rated securities), and an “Other” categoryin row 980 (which includes everything else). The ratings categories area measure of the risk associated with the assets identified as belongingto each category. The rating categories are exemplary, and more, fewer,or different categories may be used by various regulators. In addition,risk measurements other than those provided by ratings agencies are alsoconsistent with the principles of the invention.

As shown, the Amount of Assets column 920 contains an exemplary dollarvalue of assets held by a capital-regulated institution. In thisexample, the institution has $100 in U.S. Treasury bonds and cash(column 920, row 950), which regulatory agencies consider a CashEquivalent category asset; $100 worth of AAA-rated bonds, AA-ratedbonds, and Freddie Mac or Fannie Mae mortgage-backed securities (column920, row 960), which regulators consider AAA/AA/MBS category assets;$100 worth of A- to BBB-rated securities (column 920, row 970), whichare considered A to BBB category assets; and $100 in commercial loans(column 920, row 980), which are considered to fall into the “Other”category. The “Other” category also may include assets such as consumerloans, junk bonds, office buildings, fixed assets, etc., that do notfall into any of the preceding categories. Thus in the example shown bytable 900, the capital-regulated institution holds $400 in total assets(995).

The Risk-Based Ratio column 930 contains a multiplication factor foreach rating category 910. This factor weights the capital reserverequirement according to the risk associated with the assets in eachcategory. The lower the risk, the less the required reserve capital. Thehigher the risk, the higher the required reserve capital. For example,as shown in table 900, assets rated in the Cash Equivalents category 950require no capital reserve (0%), because such assets are essentiallyrisk free. A- to BBB-rated bonds 970, on the other hand, are subject toa 50% risk-based ratio 930. The risk-based ratio 930 for each ratingcategory 910 is typically set by regulatory agencies, and may change orbe different from the exemplary ratios shown in FIG. 9.

The next column in table 900 is the Base Capital Charge column 940. Inthe example shown, the base capital charge is 8% for each ratingcategory 910. The base capital charge 940 for each rating category 910is typically set by government regulators, and may change or bedifferent from the exemplary charges shown in FIG. 9. For example, ingeneral, regulatory agencies apply an 8% base capital charge to “Other”assets. There are, however, some assets in that category (e.g., veryrisky investments) that could require dollar-for-dollar reserve capital;i.e., a 100% base capital charge because of the large risk of lossesassociated with such assets.

Column 945 shows the Capital Reserve Requirements for acapital-regulated institution holding the assets shown in column 920.The capital reserve requirements 945 for each of the assets 920 in eachof the rating categories 910 is obtained by multiplying the amount ofassets 920 by the risk-based ratio 930 and the base capital charge 940.For example, the $100 worth of AAA/AA/MBS category assets (row 960,column 920) is multiplied by the 20% risk-based ratio (row 960, column930) and the 8% base capital charge (row 960, column 940) to yield acapital reserve requirement of $1.60 for these assets (row 960, column945). The total reserve capital required for the $400 worth of totalassets 995 is the sum of the capital reserve requirements for eachcategory 910, which is $13.60 (998) in this example.

Table 901 illustrates the reserve capital required for the same assetsunder the old flat ratio capital reserve requirements. Acapital-regulated institution with the assets shown in column 921 oftable 901 would be required to hold $400 (996)×6% (column 931)=$24 (999)as reserve capital against such assets. As illustrated by table 900,under the risk-based ratio capital reserve requirements, the reservecapital requirement is $13.60. Thus, in this example, the risk-basedratio capital reserve requirements reduce the reserve capital requiredby 43% over the flat ratio capital reserve requirements, reflecting thelow-risk nature of part of the total assets.

Conventionally, the risk-based ratio capital reserve requirements applyto securitized assets or securities rated by a ratings agency, such ascorporate bonds rated by Standard & Poor's. Thus, for acapital-regulated institution holding assets other than ratedsecurities, the assets fall into the “Other” category 980 and theinstitution is required to hold the maximum amount of reserve capitalagainst the assets, regardless of their qualities or characteristics.For example, if a bank held $400 in unsecuritized commercial loans, thenunder the risk-based ratio capital reserve requirements illustrated bytable 900, the bank would be required to hold $32 in reserve capitalagainst the commercial loans, even if they were as risk-free as cash.This same situation holds true for any asset that falls into a categoryrepresenting more risk than the rated risk associated with the asset.

For capital-regulated institutions, it is desirable to minimize thelevel of reserve capital that must be held under the capital reserverequirements.

SUMMARY OF THE INVENTION

The present invention includes the use of a financial instrument(referred to herein as a “Guarantee Certificate”) that takes the paymentobligations of the mortgage insurers and securities guarantors andplaces them into a separate, transferable financial instrument.Guarantee Certificates of the present invention pay an investor(s) basedon specified triggering events associated with a loan pool. Triggeringevents can be defined by loan delinquency, foreclosure on a propertybacking an insured or guaranteed mortgage, acquisition of a deed in lieuof foreclosure of the collateral, or liquidation of a property formerlybacking an insured or guaranteed mortgage. The Guarantee Certificate mayoffer payment based on a fixed percentage of the defaulted loanprincipal, payment of actual or estimated losses, or a formula thatcombines these or other elements or a multiple of the same. The loanpool for a given Guarantee Certificate could include one or more loansof any type or origin.

Issuers can create Guarantee Certificates either by restructuring thecash flows from existing insurance or guarantee arrangements, or byissuing the securities de novo. In a restructuring, the issuer poolsloans or securities already insured or guaranteed and places them in atrust. The trustee identifies and segregates the cash flows paid tosatisfy insurance or guarantee claims, and the trust issues GuaranteeCertificates entitled to receive a specified schedule of the insuranceor guarantee payments. The payments can be a straight dollar-for-dollarpass-through of the insurance or guaranty payments, or can be determinedby a formula based on the payments. In a de novo issuance, the issuerspecifies a set of loans (which may or may not be securitized) as aReference Pool and issues Guarantee Certificates entitled to receiveformula-based cash flows triggered by specified events or conditions inthe Reference Pool. The Reference pool may be static or dynamic.

In another embodiment of the present invention, systems and methods aredisclosed for using Reference Pools as credit enhancements for hedgingrisk of loss on loan investments. Such systems and methods use criteriaestablished by the parties for hedging risk of loss on the purchase andsale of loan investments. Such systems and methods may monitor theperformance of a Reference Pool and a Subject Pool of loans. The SubjectPool of loans may include loans that are the subject of the investmenttransaction. The Reference Pool may include loans having similarcharacteristics to loans in the Subject Pool. Further, such systems andmethods may compare the monitored performances of loans in the ReferencePool and the Subject Pool. At the end of a payment cycle, such as theend of a fiscal year, such systems and methods may calculate a paymentdue to the buyer or seller based on the comparison of the monitoredperformances of loans in the Reference Pool and the Subject Pool, and anestablished payment formula. Thereafter, such systems and methods maygenerate an invoice or a payment form, such as a check payable to one ofthe parties based on the calculated payment due. The effect of suchsystems and methods is to hedge against the loss resulting from thedifference in performance between the loans in the Reference Pool andthe Subject Pool. In addition, such systems and methods may generateand/or adjust the composition of the Reference Pool of loans based oncomparable attributes of the Subject Pool of loans.

Embodiments consistent with the present invention provide a creditenhancement structure for risk sharing between parties that minimizesthe regulatory capital reserve requirement impact to one or moreparties. One embodiment of a structure consistent with the inventionincludes two loan pools. The first pool is the subject pool, whichcontains the loans for which the parties will share risk. The secondpool is a reference pool that contains loans mimicking or sharing mostof the features of the loans in the first pool, except for one or morefeatures that create an unknown risk, for example, a reduced level ofborrower documentation. A ratings agency, such as Standard & Poor's andMoody's, rates the two pools separately and establishes loss coveragelevels for each of the pools. One party takes all the risk for thesubject pool up to the loss coverage level established for the referencepool, and a second party takes all or part of the risk above the losscoverage level. The second party's risk may be capped at some maximum.Because the second party's risks are limited by the loss coverage levelsand cap, the capital reserve requirements for that party are reducedcompared to holding the subject pool assets without the creditenhancement structure.

Other embodiments consistent with the present invention include systems,computer program products and methods for reducing capital required tobe held in connection with a subject pool of loans comprising theoperations of: obtaining a credit risk rating of the loans in thesubject pool, allocating credit risk for the subject pool, based on thecredit risk rating, applying capital reserve requirements to the subjectpool based on the credit risk rating and the allocated credit risk; andholding an amount of capital against the subject pool based onapplication of the capital reserve requirements.

Other embodiments consistent with the present invention include systems,computer program products and methods for reducing capital required tobe held in connection with a subject pool of assets including theoperation of: obtaining a risk rating of the assets in the subject pool,guaranteeing a portion of risk for the subject pool, based on the riskrating, facilitating application of capital reserve requirements to thesubject pool based on the risk rating and an unguaranteed portion ofrisk to determine an amount of capital held in connection with thesubject pool, monitoring performance of the subject pool to determineany guarantee obligations, and conveying funds based on any determinedguarantee obligations and the monitored performance.

Other embodiments include systems and methods for reducing capitalrequired for a subject pool of assets comprising obtaining a risk ratingof the assets in the subject pool; retaining a portion of risk for thesubject pool, based on the risk rating; applying capital reserverequirements to the subject pool based on the risk rating and theretained portion of risk; and adjusting an amount of capital heldagainst the subject pool based on application of the capital reserverequirements.

Still other embodiments include systems and methods for A method forreducing capital required to be held in connection with a subject poolof assets comprising: obtaining a risk rating of the assets in thesubject pool. obtaining a risk rating of assets in the subject pool,retaining a portion of risk for the subject pool, based on thedifference between the risk rating of the assets in the subject pool andthe assets in the reference pool, applying capital reserve requirementsto the subject pool based on the retained portion of risk, determiningan amount of capital to hold in reserve in connection with the subjectpool based on application of the capital reserve requirements; andpresenting the determined amount of capital.

Yet other embodiments include systems and methods for reducing capitalrequired to be held in connection with a subject pool of assetscomprising: obtaining a risk rating of the assets in the subject pool,obtaining a risk rating of assets in the subject pool, obtaining a riskrating of a delta between the risk rating of the assets in the subjectpool and the assets in the reference pool, retaining a portion of riskfor the subject pool, based on the risk rating of the delta, applyingcapital reserve requirements to the subject pool based on the retainedportion of risk, determining an amount of capital to hold in reserve inconnection with the subject pool based on application of the capitalreserve requirements, and presenting the determined amount of capital.

BRIEF DESCRIPTION OF THE DRAWINGS

The accompanying drawings, which are incorporated in and constitute apart of this specification, illustrate the various features and aspectsof the invention and, together with the description, explain theadvantages and principles of the invention. In the drawings,

FIG. 1 is a schematic block diagram of a data processing systemarchitecture suitable for use with the present invention;

FIG. 2 is a block diagram of the components of a system for managingGuarantee Certificates;

FIG. 3 is an exemplary flowchart of the steps performed by themonitoring component of a Guarantee Certificate system, consistent withthe principles of the present invention;

FIG. 4 is a flowchart of the steps performed by the certificate paymentcomponent of a Guarantee Certificate system, consistent with theprinciples of the present invention;

FIG. 5 is a flowchart of steps for issuing a Guarantee Certificate,consistent with the principles of the present invention;

FIG. 6 is a block diagram illustrating the process of restructuring cashflows from existing guarantee arrangements to issue GuaranteeCertificates, in accordance with the principles of the presentinvention;

FIG. 7 is a block diagram illustrating the payment process associatedwith a de novo issuance of Guarantee Certificates, in accordance withthe principles of the present invention;

FIG. 8 is an exemplary flowchart of a method for using a Reference Poolas a credit enhancement for hedging risk of loss on loan investments,consistent with the principles of the present invention;

FIG. 9 illustrates two examples of different types of capital reserverequirements;

FIG. 10 is a flowchart of a minimized-capital-reserve-requirementprocess for sharing risk on a pool of assets consistent with theinvention;

FIG. 11 is a diagram illustrating a Reference Pool and a Subject Poolconsistent with the invention;

FIG. 12 illustrates a rating assessment of two asset pools;

FIG. 13 illustrates another ratings assessment of two asset pools, suchas might result, for example, from step 1015 of the process shown inFIG. 10;

FIG. 14 is a table illustrating an exemplary risk-sharing arrangementbased on asset ratings and the resultant capital reserve requirements,consistent with the invention;

FIG. 15 is a graph depicting loss allocation for a risk-sharingstructure consistent with the invention; and

FIG. 16 illustrates an embodiment of a risk-sharing arrangement based onasset ratings that reduces capital reserve requirements consistent withthe present invention.

DETAILED DESCRIPTION

Reference will now be made in detail to an implementation of the presentinvention as illustrated in the accompanying drawings. Whereverpossible, the same reference numbers will be used throughout thedrawings and the following description to refer to the same or likeparts.

Overview

Systems and methods consistent with the present invention processinformation corresponding to Guarantee Certificates, which are financialinstruments that evidence the obligation of an insurer or a guarantor tomake payments that are triggered by certain events. The triggering eventcreates the payment obligation.

In one embodiment, a Guarantee Certificate evidences the obligation of amortgage insurer or a securities guarantor to make payments that aretriggered by events, typically, default-related events, involving arelated (in the case of a mortgage insurer) or an underlying (in thecase of a securities guarantor) mortgage loan or loans. For example, theinstrument might evidence the obligation of a mortgage insurer orsecurities guarantor to make payments to the Guarantee Certificateholder based on the payment default of a borrower or borrowers withrespect to the group (the “Reference Pool”) of related or underlyingmortgage loans (the “Reference Loans” or “Reference Pool elements”)associated with the Guarantee Certificate.

A data processing system tracks the status of the Reference Loans(elements) in a series of Reference Pools uniquely associated with eachGuarantee Certificate. When the data processing system identifies adefault under a Reference Loan or another payment-triggering event, itcalculates the amount payable to the appropriate Guarantee Certificateholder.

A unique feature of Guarantee Certificates is that they are decoupledfrom, and therefore, in one preferred embodiment, may be bought, sold,and conveyed independently of the Reference Loans and/or mortgage-backedsecurities representing an interest in the Reference Loans that are thesource of the payment-triggering events. In other words, GuaranteeCertificates can be made tradable, if the issuer so desires.

In another embodiment, a Reference Pool of loans may be used as a creditenhancement for hedging (sharing) risk of loss on loan investments. Forexample, a seller may wish to sell a pool of loans to a buyer, but thebuyer may be reluctant to purchase such loans because of a lack ofinformation to determine a default risk factor for such loans. In orderto overcome this uncertainty, the buyer and seller may enter into arisk-sharing arrangement in connection with the transaction. Forconvenience, the pool of loans is referred to as a Subject Pool. In suchan arrangement, a Reference Pool may be created with loans havingattributes that are comparable to attributes of loans in the SubjectPool.

The arrangement may stipulate a payment formula and one or more paymentcycles. At the end of each payment cycle, a payment may be made to oneparty by the other party based on the payment formula and theperformance of the loans in the Subject Pool and the Reference Pool. Forexample, at the end of a payment cycle, the data processing system mayuse the payment formula to determine the cumulative dollar losses onloans in the Subject Pool and the Reference Pool. If cumulative losseson loans in the Reference Pool exceed those of loans in the SubjectPool, the buyer may pay the seller the amount that the Reference Poollosses exceed the Subject Pool losses. However, if cumulative losses onloans in the Subject Pool exceed those of loans in the Reference Pool,the seller may pay the buyer the amount that the Subject Pool lossesexceed the Reference Pool losses.

Adjustments may be made to the Reference Pool when a change occurs tothe composition of the Reference Pool or the Subject Pool. For example,adjustments may be made to the Reference Pool when a change occurs tothe number of loans or the size (i.e., unpaid principal balance (“UPB”))of the Subject Pool or the Reference Pool due to, for example,prepayment of loans. The adjustments may include adding or deletingloans to/from the Reference Pool to maintain the relative number ofloans in the two pools or the relative total dollar amount of the UPB inthe two pools. Alternatively, the payment formula may includeadjustments to take into account the change in the number of loans orthe total dollar amount of the UPB of the Subject Pool or the ReferencePool due to, for example, prepayment of loans. Such adjustments may bemade to ensure comparability of the two pools of loans.

Reference will now be made in detail to exemplary embodiments of systemsand methods consistent with the present invention, which are alsoillustrated in the accompanying drawings. Those of ordinary skill in therelevant art will recognize from the description that other embodimentsare possible, and changes may be made to the implementations describedherein without departing from the spirit and scope of the invention.

Data Processing System Architecture

The present invention may be implemented by computers or workstationsorganized in a distributed processing system architecture, with anysuitable combination of software, hardware, and/or firmware.

FIG. 1 is a block diagram that illustrates a data processing system 100in which methods and systems consistent with the present invention maybe implemented. System 100 includes a bus 102 or other communicationmechanism for communicating information, and a processor 104 coupledwith bus 102 for processing information. System 100 also includes a mainmemory, such as a random access memory (RAM) 106 or other dynamicstorage device, coupled to bus 102 for storing information andinstructions to be executed by processor 104. RAM 106 also may be usedfor storing temporary variables or other intermediate information duringexecution of instructions by processor 104. System 100 further includesa read only memory (ROM) 108 or other static storage device coupled tobus 102 for storing static information and instructions for processor104. A storage device 110, such as a magnetic disk or optical disk, isprovided and coupled to bus 102 for storing information andinstructions.

System 100 may be coupled via bus 102 to a display 112, such as acathode ray tube, for displaying information to a user. An input device114, including alphanumeric and other keys, is coupled to bus 102 forcommunicating information and command selections to processor 104.Another type of user input device is a cursor control 116, such as amouse, a trackball or cursor direction keys, for communicating directioninformation and command selections to processor 104 and for controllingcursor movement on display 112. This input device typically has twodegrees of freedom in two axes, a first axis (e.g., x) and a second axis(e.g., y), that allow the device to specify positions in a plane.

The present invention is related to the use of system 100 for issuingand maintaining Guarantee Certificates. In addition, the presentinvention is related to the use of system 100 for utilizing referencepools as credit enhancements. These operations may involve accessinginformation from remote platforms and transmitting information to remoteplatforms. According to one implementation of the invention, informationfrom remote platforms is provided to system 100 in response to processor104 executing one or more sequences of one or more instructionscontained in main memory 106. Such instructions may be read into mainmemory 106 from another computer-readable medium, such as storage device110. Execution of the sequences of instructions contained in main memory106 causes processor 104 to perform the process steps described herein.In an alternative implementation, hard-wired circuitry may be used inplace of or in combination with software instructions to implement theinvention. Thus implementations of the invention are not limited to anyspecific combination of hardware circuitry and software.

The term “computer-readable medium” as used herein refers to any mediathat participates in providing instructions to processor 104 forexecution. Such a medium may take many forms, including but not limitedto, non-volatile media, volatile media, and transmission media.Non-volatile media includes, for example, optical or magnetic disks,such as storage device 110. Volatile media includes dynamic memory, suchas main memory 106. Transmission media includes coaxial cables, copperwire and fiber optics, including the wires that comprise bus 102.Transmission media can also take the form of radio frequency, acousticor light waves, such as those generated during radio-wave and infra-reddata communications.

Common forms of computer-readable media include, for example, a floppydisk, a flexible disk, a hard disk, a magnetic tape, any other magneticmedium, a CD-ROM, any other optical medium, a punch card, a paper tape,any other physical medium with patterns of holes, a RAM, a PROM, anEPROM, a FLASH-EPROM, any other memory chip or cartridge, a carrier waveas described hereinafter, or any other medium from which a computerprocessor can read.

Various forms of computer readable media may be involved in carrying oneor more sequences of one or more instructions and/or data to processor104. For example, instructions may initially be carried on the magneticdisk of a remote computer. The remote computer can load the instructionsinto its dynamic memory and send the instructions over a telephone lineusing a modem. A communication interface 118 local to computer system100 can receive the data on the telephone line and use an infra-redtransmitter to convert the data to an infra-red signal. An infra-reddetector coupled to bus 102 can receive the data carried in theinfra-red signal and place the data on bus 102. Bus 102 carries the datato main memory 106, from which processor 104 retrieves and executes theinstructions. The instructions received by main memory 106 mayoptionally be stored on storage device 110 either before or afterexecution by processor 104.

As shown, system 100 includes communication interface 118 coupled to bus102. Communication interface 118 provides a two-way data communicationcoupling to a network link 120 that is connected to a local network 122.For example, communication interface 118 may be an integrated servicesdigital network (ISDN) card, or a modem to provide a data communicationconnection to a corresponding type of cable or telephone line, or aninfrared-transmitting modem directly connected to local network 120 andconnected via an infrared detector to bus 102, as discussed above. Asanother example, communication interface 118 may be a local area network(LAN) card to provide a data communication connection to a compatibleLAN. Wireless links may also be implemented. In any such implementation,communication interface 118 sends and receives electrical,electromagnetic or optical signals that carry analog or digital datastreams representing various types of information.

Network link 120 typically provides data communication through one ormore networks to other data devices. For example, network link 120 mayprovide a connection through local network 122 to a host computer 124and/or to data equipment operated by an Internet Service Provider (ISP)126. ISP 126 in turn provides data communication services through theInternet 128. Local network 122 and Internet 128 both use electric,electromagnetic or optical signals that carry digital data streams. Thesignals through the various networks and the signals on network link 120and through communication interface 118, which carry the digital data toand from system 100, are exemplary forms of carrier waves transportingthe information.

System 100 can send messages and receive data, including program code,through the network(s), network link 120 and communication interface118. In the Internet example, a server 130 might transmit a requestedcode for an application program through Internet 128, ISP 126, localnetwork 122, network link 120, and communication interface 118. Inaccordance with the present invention, one such downloaded applicationprovides a bridge between two remote information sources, as describedherein. The received code may be executed by processor 104 as it isreceived, and/or stored in storage device 110, or other non-volatilestorage for later execution. In this manner, system 100 may obtainapplication code in the form of a carrier wave.

Although system 100 is shown in FIG. 1 as being connected to one server,130, those skilled in the art will recognize that computer system 100may establish connections to multiple servers on Internet 128. Each suchserver includes an Internet application such as an HTML- or XML-basedapplication, which may provide information to computer system 100 uponrequest in a manner consistent with the present invention.

The system architecture just described is exemplary. One of ordinaryskill in the art could easily substitute, replace, add, or eliminatevarious components without departing from the principles of the presentinvention. For example, the various networks and communication pathsdescribed could be implemented using DSL, cable, wireless, and/orInternet technology in place of the technology described.

Guarantee Certificates

In one embodiment, steps according to the present invention are embodiedin machine-executable software instructions, and components of thepresent invention are carried out in a processing system by a processorexecuting the instructions. In other embodiments, hardwired circuitrymay be used in place of, or in combination with, software instructionsto implement the present invention.

In one embodiment, system 100 uses four software components to supportGuarantee Certificates in a manner consistent with the presentinvention. As shown in FIG. 2, the components 200 include a databasemanagement system 210, a monitoring component 220, a reporting component230, and a certificate payment component 240.

(1) Database Management System

Database management system (“database”) 210 holds identifyinginformation, including the initial attributes, of each loan or otherelement of the Reference Pool that is the source of the “guaranteed”risk, including the identity of the Reference Pool or Reference Pools towhich each element belongs. For example, in the case of a Reference Poolof mortgages, database 210 holds information and attributes for mortgageloans in the pool. Database 210 also holds information on the ongoingstatus or performance of each element in the Reference Pool. In the caseof mortgage risk, ongoing information could include coupon history,principal balance history, payment history, delinquency history,borrower's credit history, and any other information on a variableaspect of a given loan. Database 210 may also hold informationconcerning a Guarantee Certificate itself, such as the elements in thecertificate's Reference Pool, the current holder or holders of thecertificate, and the certificate's conveyance history. Database 210 hasthe ability to accept either manual or electronic input and to delivereither printed or electronic output.

Database 210 uses a query language (such as standard query language“SQL”) to access stored information. The query language allows the userto extract data either using a keyboard or using another program withoutknowing the detailed structure of the database. For example, the usermight be able to request, using a query language query, a paymenthistory for all 30-year loans originated in 1993 without knowingprecisely where this information is located in database 210. Inaddition, database 210 includes methods of checking for possible datainput errors and/or data inconsistencies and for reporting and/orcorrecting those errors and inconsistencies.

(2) Monitoring Component

A monitoring component 220 queries and takes input from agents thatmonitor the ongoing status or performance of each element in theReference Pool, with particular emphasis on status changes thatconstitute triggering events for purposes of the payment function. FIG.3 is an exemplary flowchart of the steps performed by a monitoringcomponent of a Guarantee Certificate system, consistent with theprinciples of the present invention.

As shown in FIG. 3, the first step of the process gets informationconcerning a Reference Pool element from database 210 (step 310). Theinformation includes the identity of a status information source for theelement. The status information source is anything that can supplycurrent status regarding the element, such as a person, a computersystem such as host 124, or a database hosted on a computer system suchas server 130. In the case of a Reference Pool of mortgages, the statusinformation source is typically a mortgage servicer or other person whomonitors loan status or performance.

Next, monitoring component 220 queries the Reference Pool element'sinformation source for the current status of the element (step 320). Inthe case of a human information source, querying typically involvesgenerating a written message requesting information, such as a letter oremail message. In the case of an automated information source, queryingtypically involves an electronic service request sent across network122, or an electronic query to a database.

When an element's current status information is received in response tothe query, monitoring component 220 records the information in database210 (step 330). For a non-electronic response, such as a letter from aperson, recording the current status information in database 210typically involves manually entering the information using input device114. For an automated response, such as the electronic results of aquery to a remote database, recording typically involves automaticallysaving the information in database 210.

In step 340, if current status information for a Reference Pool elementarrives unsolicited (i.e., not in response to a monitoring componentquery), then monitoring component 220 updates database 210 with thecurrent status (step 330). If there is no unsolicited current statusinformation to process, then the monitoring component process returns tostep 310 to process another Reference Pool element.

(3) Reporting Component

Reporting component 230 allows ad hoc or standard queries to database210 and generates electronic or printed reports. In the case of aReference Pool of mortgages, this component queries database 210 andreports on payment status, delinquent status or any other attributeeither for individual loans or in the aggregate. Reporting component 230also provides information about one or more Guarantee Certificates,including descriptive information and the history of certificate holderpayments made.

(4) Certificate Payment Component

Certificate payment component 240 stores the definition of events thattrigger payments to Guarantee Certificate holders, identifies whentriggering events occur, calculates any payments due, and issuesinstructions to pay Certificate holders. FIG. 4 is an exemplaryflowchart of the steps performed by the certificate payment component ofa Guarantee Certificate system, consistent with the principles of thepresent invention.

As shown in FIG. 4, the first step of the process gets the statusinformation of a Reference Pool element from database 210 (step 410). Inthe case of a Reference Pool of mortgages, payment component 240 keeps alist of the loans in database 210 belonging to the pool and gets thestatus information of each of them.

Next, payment component 240 compares the status information to thetriggering event or events for the Reference Pool element (step 420).Payment component 240 keeps a definition of each triggering event for aGuarantee Certificate, such as reaching the status of a specified numberof days delinquent, loan foreclosure, property liquidation or anotherevent monitored or recorded by the system. If the triggering event didnot occur (step 430; No), then payment component 240 returns to step 410to process another Reference Pool element. If the triggering eventoccurred (step 430, Yes), then the process moves to step 440.

In step 440, payment component 240 calculates the payment due for thetriggering event. The calculation can involve any mathematical formularelated or unrelated to any variable measured by the system. Forexample, the payment can be a straight dollar-for-dollar pass-through ofthe insurance or guarantee payment, or a fixed percentage of theinsurance or guarantee payment, or some other amount based on a formula.Next, payment component 240 issues instructions to pay the Certificateholder or holders (step 450). This typically involves sending anelectronic or printed notice to the paying agent for the GuaranteeCertificate in question.

Payment component 240 then updates database 210 regarding the paymentmade to the Guarantee Certificate holder (step 460), and returns to step410 to process another Reference Pool element.

One of ordinary skill in the art will recognize that many modificationscan be made to the components and steps described without departing fromthe principles of the present invention. For example, monitoringcomponent 220 and reporting component 230 could be combined into asingle component that performs the functions of both.

Issuing Process

Issuers can create Guarantee Certificates either by restructuring thecash flows from existing insurance or guarantee arrangements, or byissuing the certificates de novo. FIG. 5 is an exemplary flowchart ofthe steps for issuing a Guarantee Certificate, consistent with theprinciples of the present invention.

As shown in FIG. 5, the issuer first determines whether to issue aGuarantee Certificate de novo, or by restructuring existing financialobligations (step 505). If, at step 510, the issuer decides to issue denovo Guarantee Certificates, the issuer identifies or specifies a set ofloans (which may or may not be securitized) (step 520), and pools theloans into a Reference Pool (step 530).

The issuer then determines a payout formula attributable to theReference Pool (step 535). For de novo Guarantee Certificates, theReference Pool merely acts as an index and no cash flows attributable tothe loans in the Pool are used to satisfy the de novo GuaranteeCertificate payout formula obligation.

In one preferred embodiment, the issuer determines the payout formula byanalyzing the behavior of the Reference Pool relative to a separate loanpool. For example, a de novo issuer of Guarantee Certificates for a poolof manufactured-housing loans may model the manufactured-housing loanReference Pool relative to the performance of a single-family-housingloan pool. Even if the issuer is not familiar with the performance ofthe manufactured-housing pool, by comparing it against the familiarsingle-family-housing pool, the issuer can determine a payout formulathat reflects the differences between the two. For example, if thedelinquency rate of manufactured-housing loans is twice that ofsingle-family-housing loan, then the issuer could make themanufactured-housing loan pool Guarantee Certificate payout formula (ona per loan basis) one-half of the formula used for a single-familyhousing loan pool.

In step 570, the issuer issues Guarantee Certificate(s) entitled toreceive cash flows specified by the payout formula and triggered byspecified events or conditions in the Reference Pool.

If the issuer decides not to issue de novo Guarantee Certificates (step510), then the issuer can restructure existing financial obligations toissue Guarantee Certificates. For a restructuring issue, the issueridentifies existing loans and/or securities already insured orguaranteed (step 540) and pools the loans and/or securities into aReference Pool (step 550). In contrast to de novo issuance, the cashflows used to satisfy any Guarantee Certificate obligation come from thesecurities in the Reference Pool.

In forming the Reference Pool, the issuer may choose loans or securitiesbased upon the perceived risk associated with each, the potentialmake-whole payment associated with each, or other factors. Poolinginvolves forming the loans and/or securities into an identified group.The Reference Pool may be static or dynamic. With static ReferencePools, the loans are identified when the Reference Pool is created andcannot be changed. With dynamic pools, loans can be added or removedaccording to a pre-specified eligibility rule. For example, aneligibility rule might be loans purchased by a specified entity havingspecific characteristics such as loan size or type. Dynamic pools can beused to hedge an active portfolio by reducing the need to continuallyadjust the hedge as new loans are added to the portfolio.

Next, the issuer creates a trust to hold the Reference Pool loans orsecurities (step 560). The trust obligates the trustee to identify andsegregate the cash flows paid to satisfy insurance or guarantee claimsfrom the cash flows normally paid by the underlying loans or securities.Guarantee Certificates are then issued based on the trust created by theissuer. Each Guarantee Certificate is entitled to receive a specifiedschedule of the insurance or guarantee payments (step 570). The paymentscan be a straight dollar-for-dollar pass-through of the insurance orguaranty payments, or can be determined by a formula based on thepayments.

When a Guarantee Certificate is issued, the term (time period) of aGuarantee Certificate may vary from the terms of the loans in theReference Pool. The Guarantee Certificate period may be longer orshorter than the terms of the pool elements. For example, the ReferencePool may contain 30-year mortgages exclusively, yet the issuer may issuea Guarantee Certificate with a term or 10 years or with a term of 40years.

FIG. 6 further illustrates one way in which cash flows from existingguarantee arrangements, such as insured loans, can be restructured toissue Guarantee Certificates in accordance with one aspect of thepresent invention. As shown in FIG. 6, security 610 represents a set ofinvestments, for example, a Reference Pool of loans. Associated withsecurity 610 is a traditional financial instrument 620 and a GuaranteeCertificate 630. In exchange for the purchase price, the holder offinancial instrument 620, which may be a bond or other instrumentevidencing a guarantee obligation, receives all cash flows traditionallyassociated with the guarantee obligation. For example, in the caseillustrated of a mortgage loan, the holder of financial instrument 620receives payments in the forms of: all regular interest payments (shownas coupon payments), amortization benefits, voluntary prepayments, andthe actual liquidation proceeds if the collateral underlying security610 is sold. The holder of Guarantee Certificate 630, on the other hand,receives a cash flow in the form of a make-whole payment only if thecollateral underlying security 610 is liquidated. A make-whole paymentis the difference between the full value of security 610 and the actualliquidation proceeds. Thus, the full (100%) value of security 610 isequal to the combination of the make-whole payment and the actualliquidation proceeds. By dividing the cash flows of an existing security610 as described, an issuer can create, issue, and manage a GuaranteeCertificate 630.

It is important to note that, in this example, the buyer of GuaranteeCertificate 630 pays security 610 holder for a contingent interest inthe make-whole payment, not a certain interest. The make-whole paymentof an insured mortgage loan, for example, is generated only if theunderlying security for the loan (i.e., the real estate) is sold.Typically, real estate is liquidated only when a mortgage loan is indefault. Thus, the holder of Guarantee Certificate 630 receives amake-whole payment only if the mortgage loan borrower defaults and themortgage holder liquidates the underlying real estate. The make-wholepayment also could be triggered by an event other than a real estateliquidation, such as, for example, a 30-day delinquency or foreclosure.

The purchase price sum paid to the issuer for the contingent interest ofGuarantee Certificate 630 may be set at a value relative to theparticular security, or it may be determined by auction. For example, asecurity with an extremely low likelihood of default may demand a verylow amount for the corresponding Guarantee Certificate. If, however,there is a high likelihood of default, a buyer may be willing to pay ahigher amount for the Guarantee Certificate. Whether or not the issuerhas restricted or eliminated the buyer's ability to trade a GuaranteeCertificate after issuance will also affect the initial price. Afterinitial issuance, the price a subsequent buyer is willing to pay for atradable Guarantee Certificate will be determined by various marketfactors, including the default history in the Reference Pool, andprojections of the subsequent likelihood of default within the pool.

One skilled in the art will recognize that amounts of the cash flows andthe types of triggering events can be varied without departing from theprinciples of the present invention. For example, instead ofliquidation, the cash flows to the Guarantee Certificate holder could betriggered by a payment delinquency event, such as a 180-day paymentdelinquency, a foreclosure event, or the classification of a property asReal Estate Owned (REO). For another example, instead of the entiremake-whole payment, the cash flows to the Guarantee Certificate holdercould be structured to be a fraction of the make-whole payment.

FIG. 7 is a block diagram illustrating the payment process associatedwith an issuance of de novo Guarantee Certificates associated with aReference Pool in accordance with the principles of the presentinvention. As shown in FIG. 7, a lender 710 issues a GuaranteeCertificates 720, which is associated with a security or Reference Pool,to an entity in exchange for a sum of money. Guarantee Certificate 720entitles the entity, or other holder in due course, to receivemake-whole payments should, for example, the underlying property besold. The make-whole payment is the difference between the full value ofthe security or pool and the actual liquidation proceeds. The make-wholepayment also could be triggered by an event other than a real estateliquidation, such as, for example, a 30-day delinquency or foreclosure.

Reference Pools as Credit Enhancements

Like Guarantee. Certificates, Reference Pools may be used as creditenhancements that serve as hedges for sharing risk of loss on loaninvestments. For example, a seller may wish to sell a pool of loans (the“Subject Pool”) to a buyer, but the buyer may be reluctant to purchasesuch loans because of a lack of information to determine a default riskfactor for such loans. In order to overcome this uncertainty, the buyerand seller may enter into a risk-sharing arrangement in connection withthe transaction.

In such an arrangement, the parties may agree that for a specifiedperiod of time, the performance of loans in the Subject Pool may bemonitored along with comparable loans in a Reference Pool. For example,the parties may agree to a performance monitoring term of ten years. TheReference Pool may include loans having comparable attributes that matchthose of loans in the Subject Pool. The composition of the ReferencePool will be described below in detail.

The parties may further agree that at the end of one or morepredetermined payment cycles, the performance of the two pools arecompared, and based on an agreed upon payment formula, a payment due isdetermined for one party to make to the other to hedge risk of loss inconnection with the transaction. The parties may agree to a performancemeasure for comparing the performance of the two pools. The performancemeasure may include, for example, a comparison of cumulative dollarlosses in the Subject Pool and the Reference Pool, default frequencies,delinquency rates, or any other indicator of performance.

The parties may agree that the predetermined payment cycle may occur ona periodic basis, such as an annual basis, semi-annual basis, quarterlybasis, monthly basis, weekly basis, etc. The payment formula may includea formula that specifies one or more rules for calculating a payment dueto one party by the other party. In addition, the payment formula mayinclude one or more payment conditions that trigger the time for oneparty to make payment to the other.

Adjustments may be made to the Reference Pool when a change occurs tothe composition of the Reference Pool or the Subject Pool. For example,dollar losses in the Reference Pool may be adjusted for differences inthe size of the pools due to, for example, prepayment of loans in eitherthe Reference Pool or the Subject Pool. Such adjustments may be made toensure comparability of the two pools.

An embodiment of the present invention provides for using ReferencePools to hedge risk of loss in loan investments as described above. FIG.8 is an exemplary flowchart of a method for using a Reference Pool as acredit enhancement for hedging risk of loss on loan investments,consistent with the principles of the present invention. As shown inFIG. 8, the parties may establish criteria for hedging risk of loss,such as criteria for generating a Reference Pool, a performance measure,a payment formula, a term for monitoring the performance of the loans inthe Reference Pool and Subject Pool, and a payment cycle (stage 805).For example, the parties may stipulate a term of ten years formonitoring performance of the loans in the two pools. Further, theparties may agree to an annual payment cycle basis. The criteria forgenerating a Reference Pool may include the relative size of theReference Pool in relation to the Subject Pool, for example, theReference Pool may be two times the Size of the Subject Pool.

(1) Creation of a Reference Pool

A Reference Pool of loans may be created based on the criteria forgenerating the Reference Pool and attributes of the loans in the SubjectPool. The parties may agree on the selection of the attributes in theSubject pool (i.e., comparable attributes) that may be used to identifyloans that may be included in the Reference Pool. The comparableattributes may include, for example, one or more of the following:number of loans, average dollar amount of the loans, loan originationdate, geographical location of the property securing the loan, aborrower's credit rating score (e.g., a Fair Isaacs (“FICO”) score), aloan to value ratio (“LTV”), a borrower's payment history, and type ofloan (stage 810). The type of loan may include, for example, adjustablerate loans, adjustable rate mortgage loans (ARMs), fixed rate loans,etc.

To create the Reference Pool of loans, system 100 or a loanadministrator may identify existing loans in database 210 havingattributes that match the comparable attributes of the loans in theSubject Pool. The identified loans may or may not include loans thatwere previously owned by the seller.

System 100 or the loan administrator may populate the Reference Poolwith the identified loans until the relative number of loans in theReference Pool is reached, based on the criteria for generating theReference Pool. For example, the criteria for generating the ReferencePool may specify that the relative number of loans in the Reference Poolmay include twice the number of loans in the Subject Pool. If theSubject Pool includes 10,000 loans, the Reference Pool may include20,000 loans and may have a number of loans ratio of 2:1 to the SubjectPool. The payment formula may include a multiplier for the number ofloans ratio, which in this example is ½.

Alternatively, the parties may have stipulated that the total dollaramount of the UPB of the Reference Pool may be established at two timesthe total dollar amount of the UPB of the Subject Pool. For example, thetotal dollar amount of the UPB of the Subject Pool may be $100,000,000and the total dollar amount of the UPB of the Reference Pool may be$200,000,000.

(2) Monitoring of the Reference Pool

After the Reference Pool is generated, monitoring component 220 maymonitor performance of the Reference Pool and Subject Pool for thestipulated term; in this example the term is ten years (stage 820).Monitoring component 220 may store information about the monitoredperformance in database 210.

(3) Adjustments to the Reference Pool

Adjustments may be made to the Reference Pool when a change occurs tothe composition of the Reference Pool or the Subject Pool. In thisexample, assume that the criteria for generating the Reference Poolspecifies a relative number of loans in the Reference Pool as two timesthe number of loans in the Subject Pool. If a change occurs in thenumber of loans in the Subject Pool or the Reference Pool (stage 823),monitoring component 220 may adjust the number of loans in the ReferencePool (stage 830). For example, an adjustment may be made to theReference Pool due to prepayment of one or more loans in the SubjectPool and/or Reference Pool. The adjustment may include deleting and/oradding one or more loans in the Reference Pool to maintain the relativenumber of loans in the two pools.

In an alternate example, assume that the criteria for generating theReference Pool specifies a relative dollar amount of the UPB of theReference Pool at two times the total dollar amount of the UPB of theSubject Pool, such that the UPB of the Reference Pool is $200,000,000while the UPB of the Subject Pool is $100,000,000. If a change occurs inthe number of loans in the Subject Pool or the Reference Pool (stage823), monitoring component 220 may adjust the number of loans in theReference Pool (stage 830). For example, an adjustment may be made dueto prepayment of one or more loans in the Subject Pool and/or ReferencePool. The adjustment to the Reference Pool may include deleting and/oradding one or more loans in the Reference Pool to maintain the relativeUPB size of the two pools.

Those of ordinary skill in the art will recognize that other adjustmentsmay be made to the Reference Pool due to a change in composition of theReference Pool and/or the Subject Pool.

(4) Determining a Payment Due to a Party by the Other Party

Monitoring component 220 may determine whether the end of the paymentcycle is reached, such as the end of a year (stage 825). If the end ofthe payment cycle is not reached (“No”), monitoring of the ReferencePool and the Subject Pool continues (stage 820). Otherwise (“Yes”),payment component 240 may calculate a payment due based on a comparisonof the monitored performances of the loans in the Reference Pool andSubject Pool, and the payment formula (stage 840). In this example,assume that the parties have agreed on a payment measure specifying thatdollar losses in the two pools are to be compared. Further, assume thatthe parties have agreed to a payment formula that provides forcalculating a payment due based on a dollar-for-dollar loss differencebetween the two pools. Also assume that at the beginning of the firstyear the Subject Pool has 10,000 loans and the Reference Pool has 20,000loans. Now assume that in year one the Subject Pool has $50,000 inlosses, and that the Reference Pool has $180,000 in losses. In thisexample, to find the relative dollar loss for the Reference Pool the$180,000 may be multiplied by ½ to get a value of $90,000. The dollarloss between the two pools may now be computed to get a value of $40,000(i.e., 90,000-50,000); thus, the payment due is $40,000. In calculatingthe payment due, payment component 240 may take into account anysettle-up payments made by the parties.

In another example, assume that the parties have agreed on a paymentmeasure specifying that actual dollar losses in the two pools are to becompared. Further, assume that the parties have agreed to a paymentformula that provides for calculating a payment due based on fixedpercentage, in this example, 75% of the actual dollar loss differencebetween the two pools. Also assume that at the beginning of the firstyear the Subject Pool has 10,000 loans and the Reference Pool has 30,000loans. Now assume that in year one the Subject Pool has $50,000 inlosses, and the Reference Pool has $180,000 in losses. In this example,to find the relative dollar loss for the Reference Pool the $180,000 maybe multiplied by ⅓ to get a value of $60,000. The actual loss differencebetween the two pools may now be computed to get a value of $10,000(i.e., 60,000-50,000). The payment due to the seller is 75% times$10,000, which equals $7,500.

In yet another example, assume that the parties have agreed on a paymentmeasure specifying that dollar losses in the two pools are to becompared. Further, assume that the parties have agreed to a paymentformula that provides for calculating a payment due based on adollar-for-dollar loss difference between the two pools. Also assumethat at the beginning of the first year the Subject Pool has a UPB of$15,000,000 and the Reference Pool has a UPB of $45,000,000.Accordingly, the UPB ratio of the Reference Pool to the Subject Pool is3:1, and the multiplier for the payment formula is ⅓.

Now assume that at the end of year one $5,000,000 UPB have been prepaidin the Subject Pool, such that the Subject Pool contains a UPB of$10,000,000. Also assume that at the end of year one $5,000,000 UPB havebeen prepaid in the Reference Pool, such that the Reference Poolcontains a UPB of $40,000,000. The ratio of the Reference Pool to theSubject Pool at the end of year 1 is 4:1. The multiplier for the paymentformula may be adjusted to take into account the change in thecomposition of the two pools, such that the multiplier becomes ¼ insteadof ⅓. Now assume that at the end of year one the Subject Pool has$50,000 in losses, and the Reference Pool has $160,000 in losses In thisexample; to find the relative dollar loss for the Reference Pool the$160,000 may be multiplied by ¼ to get a value of $40,000. The dollarloss between the two pools may now be computed to get a value of $10,000(i.e., 50,000-40,000); thus, the payment due to the buyer is $10,000.

In another example, assume that the parties have agreed on a paymentmeasure specifying that the number of defaults in the Subject Pool andReference Pool are to be compared. Also assume that the parties haveagreed to a payment formula that provides for calculating a $100 paymentfor each default difference between the two pools. In addition, assumethat at the beginning of the first year the Subject Pool has 10,000loans and the Reference Pool has 30,000 loans. Now assume that in yearone the Subject Pool has 500 defaults, and the Reference Pool has 900defaults. To find the relative defaults for the Reference Pool the 900may be multiplied by ⅓ to get a value of 300 defaults. In this example,the Subject Pool has 200 more defaults than the Reference Pool (i.e.,500−300). The payment due to the buyer may now be computed to get avalue of $20,000 (i.e., $100 times 200).

(5) Determining Whether to Generate an Invoice or a Payment Form

Payment component 240 may determine to which party the payment is due,and whether to generate an invoice or a payment form, such as a check ora request for an electronic transfer of funds (stage 845). For example,if the performance of the Reference Pool is inferior to the performanceof the Subject Pool, payment component 240 may generate a check onbehalf of the buyer for payment to the seller in the amount of thepayment due (stage 860). However, if the performance of the Subject Poolis inferior to the performance of the Reference Pool, payment component240 may generate an invoice instructing the seller to make payment tothe buyer in the amount of the payment due (stage 850).

If the payment formula includes a payment condition that triggers thetime for one party to make payment to the other, payment component 240may issue the check or invoice once the payment condition is triggered.For example, the payment formula may include a payment condition that istriggered when there is a difference of at least $25,000 in cumulativelosses between the Subject Pool and the Reference Pool. If the PaymentConditions is satisfied, system 100 may issue the check or invoice asdescribed above.

Finally, system 100 may determine whether the end of the term formonitoring the performance of the two pools is reached (stage 870). Ifthe end of the term for monitoring is reached (“Yes”), monitoring of theReference Pool and Subject Pool ends. Otherwise (“No”), monitoringcomponent 220 resumes monitoring of the Reference Pool and Subject Pool(stage 820).

Risk-Based Reference Pools

Although embodiments consistent with the invention are sometimesdescribed below in terms of a reference-pool-based, loan risk-sharingarrangement between a capital-regulated institution, such as a bank, andan entity that buys or guarantees loans, such as Freddie Mac, one ofordinary skill in the art will recognize that the invention is notlimited merely to these entities, assets, requirements, andtransactions, but is instead applicable to a broad range ofinstitutions, entities, assets, requirements, and transactions.Furthermore, although the described embodiments may refer to risk interms of the risk of loss, risk also includes the risk of a lesser gainand other types of risk as well.

One embodiment consistent with the present invention enables a bank tosell or otherwise convey loans or other assets to a guarantor, such asFreddie Mac, even though the loans have some unknown risk associatedwith them that makes the loans undesirable to the guarantor, such asloans that have been originated using nonstandard processing anddocumentation and loans to higher risk borrowers. This embodiment uses areference pool structure with which the guarantor identifies,segregates, and assigns responsibility for a portion of risk, such asthe unknown portion of risk, to the bank. One embodiment consistent withthe invention applies the bank capital guidelines for externally-ratedsecurities to a pool of non-securitized assets, such as loans, toestablish the capital reserve requirements for a regulated institution,and caps the institution's risk exposure based on the rating results ofthe asset pool.

Capital-Reducing Risk Sharing Process

FIG. 10 is a flowchart of a minimized-capital-reserve-requirementprocess for sharing risk on a pool of assets that may be implementedusing software programs, computers, and other data processing equipmentand operations. The process illustrated in FIG. 10 begins by determiningthe characteristics of a group of assets having some unknown riskassociated with them (step 1005). The group of assets is referred to asthe subject pool. The characteristics may reflect any qualities thatdescribe and specify the assets. For example, the characteristics of asubject pool of home mortgage loan assets may include the average,median, and/or total of the unpaid principal balance (UPB) of the loans,the average, median, and/or total loan to value (LTV) ratio of theloans, the geographic location of the properties securing the loans, theFICO scores of the borrowers, the types of properties securing the loan(e.g., single-family, multi-family, commercial), the identity of theoriginator, the average, median, and/or total term in years of theloans, the method or guidelines used to originate the loans, and othercharacteristics.

Next the process creates a reference pool of assets having similarcharacteristics to the assets in the subject pool (step 1010). Areference pool is typically used because the assets in the subject poolmay have some unknown risk associated with them, whereas reference poolassets ideally have mostly known risks. One of ordinary skill in theart, however, will recognize that the principles of the invention canalso be applied to assets that do not have an associated unknown risk.One of ordinary skill will also recognize that the invention may beapplied without using a reference pool. For the loan asset example, theloans in the subject pool may have an unknown risk because they wereoriginated using a reduced-documentation procedure that does not complywith industry standard documentation guidelines, as would be the case ifthe loan originator used a reduced paperwork, quick approval procedureand did not verify the borrowers' current income, employment, and/orassets. Or, the borrowers may be higher risk according to industryguidelines. The reference pool assets, on the other hand, arefamiliar-risk assets without unusual characteristics that might affecttheir expected behavior in some unknown fashion.

For an example, refer for a moment to FIG. 11, which is a diagramillustrating an exemplary reference pool and an exemplary subject poolconsistent with the invention. Reference pool 1110 containsstandard-documentation loans having characteristics or attributes suchas UPB, LTV, FICO Score, geographic location, etc., similar to that ofthe low documentation loans in subject pool 1120. Although the referencepool loans 1110 generally mimic the characteristics of the subject poolloans 1120, they are different with respect to at least onecharacteristic, such as the case where they were all originated incompliance with the standard documentation guidelines, while the subjectpool loans were not. Thus, because the reference and subject pools arecomparable in almost all respects, with the exception of originationprocessing and documentation, any variation in behavior between the twopools should be due to the unknown risk associated with thereduced-documentation origination procedure used for the subject poolloans 1120. The matched sample of loans in the reference pool 1110provides a way of holding constant sources of variation in risk betweenthe two pools, other than the risk due to the different documentationcharacteristic.

The reference pool structure provides a way to separate or isolate theincremental risk (of loss or reward) due to the unknown-riskcharacteristic of the loans in the subject pool 1120, in this case dueto the reduced-documentation origination procedure. Because themarketplace understands the risks of the familiar assets in thereference pool, one party can provide appropriate hedges or insuranceand hedge prices for the assets in the subject pool to the extent theyconform with the performance of the reference pool, and the other partycan accept responsibility for any losses or gains beyond those of thereference pool. One of ordinary skill will recognize that the describeddocumentation characteristic is merely exemplary, and the matched sampleof loans comprising the reference pool 1110 can be chosen to isolate theperformance associated with almost any characteristic of the loans inthe subject pool 1120. For example, reference pool 1110 may be composedof loans where the borrowers have average FICO scores while subject pool1120 contains only loans where the borrowers have FICO scores in thebottom quartile.

A reference pool's 1110 performance is affected by the same market riskas the subject pool 1120. Thus, the difference in performance betweenthe reference pool and the subject pool is attributable to thedifference in characteristics, such as reduced-documentation originationprocess. If the subject pool 1120 performs as well as or better than thereference pool 1110, then the difference in characteristics may increaseasset performance or reduce asset risk. The parties may agree to sharethe risk indicated by performance differences in any way they choose. Inone embodiment consistent with the invention, the incremental riskbeyond the reference pool risk for a loan pool is capped for theoriginator at a specified maximum cap level, above which any furtherlosses are absorbed by the guarantor. The cap level, as well as theguarantee fee for the cap, may be set at the start of the reference poolarrangement. In another embodiment, the cap level may be determined by aratings agency analysis of the reference pool and/or subject pool, in amanner similar to that described below.

Returning again to FIG. 10, once the reference pool has been created,the risks associated with the subject pool and the reference pool arerated (step 1015). In one embodiment, one or more nationally recognizedrating agencies, such as Standard & Poor's and Moody's, evaluates theassets in the pools. The ratings agency assigns separate ratings for thereference pool and the subject pool. As is well known in the art, theratings categories range from unrated (high risk) through AAA (lowrisk). In one embodiment consistent with the invention, the ratingsagency may also provide a rating on the ratings level differencesbetween the two pools. Based on the subordination levels (e.g., thepercentage of a pool that is rated lower than a specific ratingscategory) determined by the ratings agency, the parties to therisk-sharing arrangement determine the risk exposure for the pools.

Next, the parties divide risk responsibilities or exposure based on theratings of the subject pool and the reference pool (step 1020). Riskdivision may be accomplished by a formal contract, informal agreement,securities issuance, obligation instruments, or other means that createa risk-sharing arrangement or structure among the participating partiesand specify the responsibilities and obligations of each party. Arisk-sharing contract or agreement may be produced automatically by asoftware application program, using information about the pools, theratings, and the parties' desired risk exposure as inputs. The risksbeing shared vary according to the type of asset in the pools. In thecase of loan assets, the risk is primarily credit risk, which is therisk of loss due primarily to a borrower defaulting on the loan. Whenrisk responsibilities are divided, the parties allocate the credit riskso the risk is shared between them, such that one party is assigned oneportion of any credit-related losses or other losses, and another partyis assigned another portion of such losses. The parties to therisk-sharing arrangement may be any number of persons or entities, forexample, banks, government-sponsored enterprises (GSEs), investors, andinsurance companies.

In one embodiment, a guarantor accepts responsibility for all losses inthe subject pool until the level of losses actually experienced by thereference pool is met. In another embodiment, a guarantor acceptsresponsibility on a per-ratings-category basis for losses in the subjectpool in each ratings category up to the level of losses experienced bythe reference pool in the equivalent ratings category. Yet otherembodiments utilize combinations of ratings category loss differencesbetween the pools and the total cumulative loss difference between thepools to divide risk responsibility among the parties.

In accordance with capital reserve requirements, after risk division andassignment, the institution's capital reserve requirements are reducedto reflect the ratings of the assets in the pools and the risk that theentity is responsible for bearing (step 1025). This operation may beaccomplished by automated accounting software applications, andtypically involves the approval of appropriate regulators. Because thedegree of risk associated with a pool of assets is revealed by theratings, and because the capital-regulated institution does not bear allthe risk, (but instead shares a portion of it with the guarantoraccording to the risk responsibility division), the capital-regulatedinstitution's resultant capital reserve requirement is lower than itwould be if the institution simply held the subject pool assets.

In another example, the subject pool of assets is rated and securitized,and then the risk-based ratio capital reserve requirements are applied.For example, seven different securities, rated AAA through unrated (UR),may be issued for a given reference pool. In yet another embodimentconsistent with the invention, a phantom security that entitles theholder to one or more cash flows associated with the subject pool assetsis issued and the risk-based ratio capital reserve requirements applied.

In one embodiment consistent with the invention, unsecuritized loans orother unsecuritized assets are treated the way rated securities aretreated under the capital reserve requirements. For example, risk-basedratio capital reserve requirements are applied to rated loan assets in amanner acceptable to the regulatory agencies.

Data processing equipment monitors the performance (e.g., the losses orgains) of the subject pool assets and the reference pool assets (step1030), and facilitates the conveyance of funds to the appropriate partybased on the risk sharing agreement and relative performance of thepools (step 1035). These last two steps are essentially the same asdescribed in the sections of this application regarding GuaranteeCertificates and reference pools as credit enhancements.

Asset Ratings Assessment

FIG. 12 illustrates a simple rating assessment of two asset pools. Asshown, a ratings agency rates asset pool 1210 containing $100 millionworth of assets as being 95% AAA-rated 1215 and 5% unrated 1220. Theunrated portion 1220 reflects the risky assets in the pool 1210, such asexpected default costs for the case where the assets are mortgages. Inone embodiment consistent with the invention, a pool of assets issubmitted for rating by two or more rating agencies, such as Standard &Poor's and Moody's, and the lower rating, i.e., the one resulting in thehighest subordination levels for an asset pool, is used. In anotherembodiment, the assets are rated by one or more of the risk-sharingparties. In yet another embodiment, a computer statistically rates theasset pools based on their characteristics. The type of assetscomprising the pool are not critical to the invention. The assets may beloans, such as mortgage loans, commercial loans, or personal loans,bonds, other debt, ownership interests, stocks, or other assets.

Consider the example where the pool assets are mortgage loans and theunpaid principal balance (UPB) of the pool is $100 million. The ratingsagency evaluates the loans in the pool, to determine, for example, howmany are likely to default, how many are likely to prepay, etc., andconcludes that 95% of the mortgages are AAA-rated 1215, and theremaining 5% deserve an “unrated” rating 1220.

The loss coverage levels of the pool are related to the ratings. Losscoverage levels are the portion of a pool of assets, typically expressedas a percentage in basis points, that must be subordinated to the seniorportion(s) of the pool in order to obtain a certain rating or ratingsfor the senior portion(s). Thus, for asset pool 1210, the seniorAAA-rated portion 1215 (i.e., the portion above the 5% subordinateunrated portion), has a loss coverage level of 500 basis points, whichis $5 million for the $100 million dollar asset pool 1210. In otherwords, in order to receive a AAA rating on 95% of the asset pool 1210,5% of that pool must be subordinate to the AAA portion 1215′, such thatthe 5% unrated portion 1220 absorbs the first 5% of losses for the assetpool 1210.

Therefore, the party (or parties) responsible for the risk of theunrated portion 1220 (which may, for example, be a party in arisk-sharing arrangement for asset pool 1210 or the holder of a securityrepresenting that piece) absorbs the first $5 million of any losses forthe asset pool 1210. For example, suppose that a borrower on one of themortgages in the pool 1210 defaults on the loan, and the mortgage ownertakes over the property and eventually sells it after paying expenses,such as maintaining the property while it is on the market, paying areal estate agent's commission, etc. Suppose further that when theborrower defaulted, there was $100,000 outstanding on the mortgage loan,the property sold for $80,000, and expenses totaled $10,000, leaving aloss of $30,000 on the $100,000 mortgage balance. If the total lossesfor asset pool 1210 up to the time of the $30,000 loss are less than $5million, then the party or parties responsible for the risk associatedwith the 5% unrated portion 1220 absorb the $30,000 loss. If, on theother hand, the total losses for asset pool 1210 at the time of the$30,000 loss are $5 million or more, then the party or partiesresponsible for the 95% AAA rated portion 1215 absorb the $30,000 loss.

It does not matter which specific loan or individual asset among assetpool 1210 causes the loss because responsibility for the loss is dividedbased on the loss coverage levels. Thus, if asset pool 1210 experiencedhundreds of defaults (or one large default) totaling $5.1 million, thenthe party responsible for the subordinate unrated portion 1220 loses $5million and the party responsible for the AAA-rated portion 1215 loses$100,000.

In embodiments where asset pool 1210 comprises loans, mortgage assets,or mortgage-backed securities, loss does not refer to the value of theunderlying assets. The party with an interest in each portion isexpecting an income stream, not an increase in asset value. Whendefaults and other loss-triggering events occur, that income stream isreduced, and in the extreme case can vanish. Thus, the value of the poolportions has no relation to the value of the underlying properties, itis instead based on the cash flows. A mortgage-backed security's cashflow, for instance, is typically a pass through, so whatever cash flowis coming from the mortgages (from the borrowers) passes through to thesecurity holder. To the extent that a borrower stops making the paymentsand a property goes into foreclosure, that borrower's loan gets pulledout of the pool as a pay off, and any associated losses are attributedto the lowest available level of subordinate portions of the pool ofmortgages containing the loan. The same principles can apply to pools ofother types of assets.

If a pool of assets is securitized, the variously-rated securities canbe offered on the market, and the security holders absorb losses basedon the loss coverage levels for the pool associated with the securities.

The other asset pool 1230 illustrated in FIG. 12, shows exemplaryratings for another $100 million dollar pool of assets. In this example,the ratings agency determined that only 2% of the pool balance 1230 needto be subordinated with an “unrated” rating 1240 to achieve a AAA ratingfor the other 98% of the pool of assets 1235, which makes the AAA-ratedportion's 1235 loss coverage level $2 million. In this example, theratings agency may have determined that pool 1230 contains much betterloans than pool 1210, having, for example, lower LTVs and higher FICOscores, and thus resulting in the different loss coverage level.

FIG. 13 illustrates a ratings assessment of two asset pools, such asmight result, for example, from rating a subject pool 1310 and areference pool 1350 in step 1015 of FIG. 10. As shown in FIG. 13, aratings agency rates the subject pool 1310 as containing: 23 basispoints (bps) of unrated assets 1326; 23 bps of B-rated assets 1325; 24bps of BB-rated assets 1324; 51 bps of BBB-rated assets 1323; 72 bps ofA-rated assets 1322; 170 bps of AA-rated assets 1321; and 9637 bps ofAAA-rated assets 1320. Similarly, the reference pool 1350 is rated ascontaining: 15 bps of unrated assets 1366; 15 bps of B-rated assets1365; 15 bps of BB-rated assets 1364; 33 bps of BBB-rated assets 1363;47 bps of A-rated assets 1362; 114 bps of AA-rated assets 1361; and 9761bps (the remainder) of AAA-rated assets 1360. In FIG. 13, the losscoverage levels for each rating are also illustrated. For example, theunrated portion 1366 of reference pool 1350 absorbs the first 15 bps1376 of losses for the assets in the pool. Similarly, the B-ratedportion 1365 absorbs any losses greater than 15 bps 1376 up to 30 bps1375, the BB-rated portion 1364 absorbs losses greater than 30 bps 1375up to 45 bps 1374, the BBB-rated portion 1363 absorbs losses greaterthan 45 bps 1374 up to 78 bps 1373, the A-rated portion 1362 absorbslosses greater than 78 bps 1373 up to 125 bps 1372, the AA-rated portion1361 absorbs losses greater than 125 bps 1372 up to 239 bps 1371, andthe AAA-rated portion 1360 absorbs losses greater than 239 bps 1371 forthe pool. Thus, for the AAA-rated portion 1360 of the reference pool1350, the loss coverage level is 239 bps.

Any entity and method agreeable to the parties in the risk-sharingarrangement and to the capital regulators may be used to rate the assetpools as illustrated. In one embodiment, the rating is performed by aratings agency such as Standard & Poor's or Moody's. In anotherembodiment, a computer software application provides ratings for theasset pools.

Capital Reserve Requirement Based on Ratings and Risk Sharing

To illustrate how the ratings could affect the capital reserverequirements of a capital-regulated institution in some simplenon-mortgage asset examples, refer again to FIG. 12. Under risk-basedratio capital reserve requirements, if a capital-regulated institutionheld the $100 million asset pool 1210, and the pool 1210 had not beenrated by a ratings agency, then the entire pool 1210 would fall into the“Other” category 980. Referring to table 900 in FIG. 9, the risk-basedratio 930 for the unrated pool 1210 is 100% and the base capital charge940 is 8%. Therefore, the institution would have to hold reserve capitalagainst the $100 million pool 1210 in the amount of $100million×100%×8%=$8 million.

Now consider the case where the institution has the pool 1210 shown inFIG. 12, the pool has been rated by a ratings agency, and the ratingsresulted in the two tranches or portions shown in FIG. 12 ($95MAAA-rated and $5M unrated). If regulators apply typical risk-based ratiocapital reserve requirements to the pool based on its ratings tranches,the institution has to hold capital in the amount of $95million×20%×8%=$1.52 million for the AAA-rated tranche 1215, and $5million×100%=$5 million for the unrated tranche 1220, for a total of$6.52 million. Thus, using risk ratings reduces the institution'scapital reserve requirement for pool 1210 by about 18% in comparison tothe previous example, even though the institution had to hold 100%capital in connection with the “unrated” portion of the pool undertypical capital requirement regulations. And, this capital reductionresults even before employing a risk-sharing arrangement to furtherreduce or cap the institution's risk and further reduce the capitalreserve requirement. Ratings, along with a risk-sharing structure, helpdetermine the total risk exposure of the institution for the pool ofassets under the risk-based ratio capital reserve requirements.

As illustrated by FIG. 9, the risk-based capital reserve requirementsrecognize that certain securities are less risky than others, and thatthe risk is reflected in the rating of a security. Consequently, therisk-based capital reserve requirements mandate that banks and othercapital-regulated institutions hold less reserve capital againstlow-risk-rated securities on their books than against high-risk-ratedsecurities.

Methods and systems consistent with the present invention apply the samelogic to other assets that the current risk-based capital reserverequirements do not cover, such as pools of loans, because just as withbonds and other securities, all loans are not the same. It is notequitable or necessary to require the same amount of capital to be heldin reserve to back all loans. Different investments and assets havedifferent known risks associated with them, and those risks are oftenratable. For example, a pool of standard prime mortgages with 2% creditprotection may be rated AAA, while a pool of subprime mortgages with 2%credit protection may be rated BB because subprime borrowers typicallymake a lower down payment (meaning a higher LTV ratio) and have amarginal FICO score, along with any of a host of other negative factorsthat make a subprime borrower a higher risk than a prime borrower. Yet,a bank may still lend money to a subprime borrowers, despite the higherprobability of loss, and be faced with the problem of minimizing itscapital reserve requirements for the loans. The different qualities ofeach borrower and each loan result in a layering of credit andcollateral risk from less risky to more risky, just as with otherassets.

In one embodiment consistent with the invention, an institution'scapital reserve requirements are reduced further if it arranges withanother party, such as a guarantor, to share the risk of loss associatedwith the assets in a pool. FIG. 14 is a table illustrating an exemplaryrisk-sharing arrangement and the resultant capital reserve requirementsconsistent with one embodiment of the invention. As shown, in table1410, columns 1412 and 1435 enumerate the rating categories unrated (UR,most risky) through AAA (least risky). Column 1415 shows the losscoverage levels in basis points for a rated subject pool and column 1420shows the size, in bps, of each category of the subject pool. Similarly,columns 1425 and 1430 show the loss coverage levels and tranche size ineach ratings category for a rated reference pool to which theperformance of the subject pool is compared. Column 1440 shows thedelta, or difference, between the reference pool category size and thesubject pool category size for each ratings category. For example, inthe BB category, the subject pool has 24 bps of BB-rated assets and thereference pool has 15 bps of BB-rated assets making a difference of 9bps for this category. Column 1445 shows the capital charge for eachasset category under the risk-based ratio capital reserve requirements,and column 1450 shows the risk-based capital reserve requirement for abank or other capital-regulated institution, which, in this exemplaryrisk-sharing arrangement, is based on the deltas 1440 in each category.The capital charge 1145 is an exemplary representation of the capitalcharges set by regulators. The capital charge 1145 may vary depending onstate and federal capital reserve regulations. In one embodimentconsistent with the invention, to determine the bank's risk-basedcapital reserve requirement, the parties apply the provisions of thebank capital standards, (such as 12 C.F.R. Chapter 1, Table B, p.59633), for externally rated assets. In the example shown in FIG. 14,the total risk-based reserve capital required for the bank is 20.8 bps(1460). The risk-sharing arrangement shown may be generated by asoftware application program using as input the pool ratings, the bankcapital standards, and risk limits and other parameters provided by theparties.

In an exemplary embodiment of a risk-sharing arrangement consistent withFIG. 14 and the present invention, the parties, such as a bank, and aguarantor, such as Freddie Mac, structure an arrangement such that ifthe subject pool does not perform as well as the reference pool, thebank's risk exposure under the structure is equal to the differencebetween the subject pool and reference pool sizes for each tranche. Thatis, the bps size difference 1440 between columns 1420 and 1430determines the bank's exposure in each rating category. In this example,the total, worst-case, risk exposure for the bank is 124 bps (655),which is the total of all the differences in each category (column1440).

As shown in columns 1445 and 1450, and by the absence of a delta 1454,the guarantor or some other party holds the AAA-rated portion of thesubject pool in this example, so there is no reserve capital associatedwith the AAA-rated portion of the subject pool in the illustratedstructure. If the bank held the AAA-rated portion, however, it wouldhave to hold capital in reserve against the risk that the guarantordefaults, and the capital charge would typically be 1.6% (not shown inthis example). Typically, the bank's decision to hold AAA-rated assetsis more dependent on interest rate risk management and portfoliomanagement than on credit-risk management.

In one embodiment consistent with the invention, the subject pool andreference pool are rated to determine external, market-based views ofcredit risk for each pools, and the ratings of the two pools are used toestablish the maximum amount of performance delta 1440 that must becovered by the regulated institution. As described previously, theindividual subject pool ratings also allow the regulated institution togain risk-based capital advantages for the rated assets.

In another embodiment consistent with the invention, not only are thereference pool and the subject pool both rated, but the differences, ordeltas, between the two ratings are also rated and used in structuringthe risk-sharing arrangement. Rating the actual delta of the poolsallows for a single risk rating that captures the view of risk inherentin both the subject pool and reference pool. This enables a regulatedinstitution to achieve the capital advantages of a rated risk position,consistent with the principles of the invention. In terms of the overallreserve capital requirement, it may be to an institution's advantage toobtain a single risk rating or “layered” risk rating on the deltaportion only.

Risk Sharing Allocation Arrangement

FIG. 15 is a graph depicting loss allocation for a loss-sharing orrisk-sharing arrangement consistent with the table shown in FIG. 14. Inthe example shown, the subject pool did not perform as well as thereference pool. The graph depicts the loss distributions for the subjectpool (shown as a solid line 1505) and the reference pool (shown as adashed line 1506) according to the subordination levels in the tableshown in FIG. 14.

In one embodiment consistent with the invention, the losses 1510experienced by both the reference pool and the subject pool are trackedover time 1515. As losses accumulate in the subject pool 1505, they areallocated to either the bank or the guarantor based on the performanceof the reference pool 1506 and according to the terms of therisk-sharing agreement between the bank and guarantor. At time T1 (720)(the time periods are arbitrary and not critical to the invention), thesubject pool has experienced 23 bps of loss. According to therisk-sharing structure shown in FIG. 14, at time T1, the guarantor isresponsible for 15 bps of loss, which corresponds to the losses on thereference pool 1506, and the bank is responsible for the remaining 8 bpsof loss during that period of time. The 8 bps assigned to the bankcorresponds to the delta for the unrated tranche category (shown incolumn 1440 of FIG. 14). For the illustrated risk-sharing agreement, theguarantor has guaranteed the bank that of the first 23 bps of lossexperienced by the subject pool of assets, which corresponds to the losscoverage level for the “unrated” portion of the subject pool, theguarantor will absorb 15 bps, and the bank will absorb the remaining 8bps. Thus, the bank's risk for the first 23 bps of subject pool loss iscapped at 8 bps. In the embodiment shown, the terms of the risk sharingagreement are based on the ratings illustrated in FIG. 14 and on therelative performances of the subject pool and reference pool. In otherembodiments, the risk-sharing parties may agree to divide the risk basedon other factors or performance models.

As shown in FIG. 15, as time progresses, both the subject and referencepool losses accumulate, with the bank bearing the incremental risk onsubject pool losses above those of the reference pool for each ratingcategory. At the end of period T2 (1525), the subject pool hasexperienced an additional 23 bps of loss, for a total of 46 bps, whilethe reference pool experienced another 1.5 bps of loss. Of thisadditional 23 bps of subject pool loss, the guarantor is responsible for15 bps, and the bank responsible for 8 bps. For the illustratedrisk-sharing structure, the reference pool acts as a first loss positionat any point in time with the guarantor taking the losses experienced bythe subject pool up to the reference pool loss level for each ratingcategory.

At the end of period T3 (1530), the subject pool has experienced another24 bps of loss, for a total of 70 bps, while the reference poolexperienced another 15 bps of loss, for a total of 45 bps. Thus, at theend of period T3 (1530) the guarantor has been responsible for a totalof 45 bps of loss (15+15+15), and the bank responsible for 25 bps(8+8+9).

Similar loss distribution is plotted for time periods T4 (1535), T5(1540), and T6 (1550). During period T4 (1535), for the next 51 basispoints of subject pool loss, the guarantor takes 33, and the bank 18.For the next 72 basis points of loss in period T5 (1540), the guarantortakes 47, and the bank 25. For the next 170 basis points of loss inperiod T6 (1545), the guarantor takes 114, and the bank 56.

In the embodiment shown, after period T6 (1545), all further losses aretaken by the guarantor, because at this point the bank has reached themaximum loss cap of 124 bps for which it is responsible under therisk-sharing structure agreed to (1455 on FIG. 14). Thus, the maximumexposure to the bank is 124 bps even under extreme scenarios. Forexample, if the subject pool experienced a 500 bps loss by the thirdyear, while the reference pool experienced 100 bps of loss, theguarantor would be responsible for 376 bps under this risk-sharingarrangement; i.e., the 100 bps corresponding to the reference poolequivalent losses plus the remaining 276 bps not covered by the bank.Thus, the bank's risk is capped, which reduces its capital reserverequirement under applicable regulations. In another embodimentconsistent with the invention (not shown), the parties' loss-coverageobligations are not distributed or triggered on a per-category basis.For example, in one alternative embodiment, the obligations may betriggered by the total sub-AAA loss coverage level for the entiresubject pool. Thus, if the subject pool performed identically to thereference pool, then the bank would bear no loss because the differencebetween the AAA subordinated portions of the reference pool and thesubject pool would be zero.

Another embodiment consistent with the present invention does notutilize a reference pool. In this embodiment, the subject pool is ratedand a guarantor shoulders some of the risk, as described above. Insteadof comparing the performance of the subject pool to a reference pool,however, the performance of the subject pool is compared to apredetermined level or levels, in each rating category or overall. Forexample, the parties may agree that for the unrated portion of thesubject pool, the guarantor will cover the first 20 bps of loss, and thebank will be responsible for the next 7 bps of losses. The parties mayfurther agree that for the B-rated portion of the subject pool, theguarantor will be responsible for the first 17 bps of loss, and the bankwill be responsible for the next 9 bps, and so on, establishing firstloss levels covered by the guarantor for each rating category,establishing incremental loss levels covered by the bank for each ratingcategory, and capping the total loss limit for which the bank isresponsible. In this embodiment, the bank may obtain more favorablefirst loss levels and a more favorable total liability cap by paying ahigher fee to the guarantor, and may customize its capital reserverequirement by specifying the first loss levels and total liability capfor the risk-sharing structure. This embodiment, however, arguablysubjects the parties to market risk that is mitigated by the previouslydescribed embodiment.

In another embodiment consistent with the invention, a reference pool isused as described above, but ratings of the reference pool and subjectpool are not used to trigger loss liabilities. Instead, the banknegotiates a total liability cap with the guarantor and pays anappropriate fee for the negotiated cap. The absolute liability capreduces the bank's risk exposure and thus its capital reserverequirement under the applicable regulations.

FIG. 16 illustrates another embodiment of a risk-sharing arrangementthat reduces capital reserve requirements, consistent with the presentinvention. As shown, asset pool 1615 has been rated as comprising asenior, AAA-rated portion 1610 and a subordinate, BB-rated portion 1620.In this embodiment, each party to the risk-sharing arrangement, such asa bank and a guarantor, is responsible for a predetermined share of therisk associated with each rated portion of the asset pool 1615. Asshown, for the AAA-rated portion 1610 of the pool 1615, the guarantor isresponsible for 40% of the losses experienced 1612, and the bank isresponsible for 60% 1614. Similarly, for the BB-rated portion 1620 ofthe pool 1615, the guarantor is responsible for 65% of the lossesexperienced 1622, and the bank is responsible for 35% 1624. Theproportion of responsibility for each rated portion 1610 and 1620 may beoptimized to minimize reserve capital requirements for the bank; and amaximum liability cap for the bank may be set for each rated portionand/or for the asset pool 1615 as a whole.

Several embodiments of the present invention described above includeregulatory agencies and ratings agencies treating non-security assets,such as general loan assets and mortgage loan assets, in the same manneras securities even if those assets have not been converted intosecurities. One of ordinary skill will recognize that the assets couldbe securitized before or after rating and applying risk-based ratiocapital reserve requirements, without departing from the principles ofthe invention. Furthermore, although several embodiments described aboveuse specific exemplary risk-based ratios and base capital charges forillustration (often based on past or current federal or state capitalreserve requirements), one of ordinary skill will recognize that theprinciples of the invention apply as well to ratings categories,risk-based ratios, base capital charges, and capital reserverequirements other than those used in the examples, including any thatmay be implemented in future federal or state capital reserverequirement regulations.

CONCLUSION

Other embodiments of the invention will be apparent to those skilled inthe art from consideration of the specification and practice of theinvention disclosed herein. It is intended that the specification andexamples be considered as exemplary only, with a true scope and spiritof the invention being indicated by the following claims.

1. A method, implemented using a data processing system, for reducingcapital required to be held in connection with a subject pool of loanscomprising: obtaining, as an input to the data processing system, acredit risk rating of the loans in the subject pool; allocating, usingthe data processing system, credit risk for the subject pool among aplurality of parties, based on the credit risk rating and a lossperformance of the subject pool in comparison to a reference pool ofloans having similar characteristics to the loans in the subject pool;applying, using the data processing system, capital reserve requirementsto the subject pool based on the credit risk rating and the credit riskallocated to a party subject to the capital reserve requirements forloans in the subject pool; calculating, using the data processingsystem, an amount of capital to hold against the subject pool based onapplication of the capital reserve requirements; and providing anindication of the amount of capital to hold to the party.
 2. The methodof claim 1, wherein allocating credit risk for the subject pool furthercomprises: for the party subject to the capital reserve requirementsfrom the plurality of parties, capping a portion of the credit riskallocated to the party at a maximum level.
 3. The method of claim 2,wherein the maximum level is a percentage of the subject pool value. 4.The method of claim 1, wherein allocating credit risk for the subjectpool comprises: assigning a portion of the credit risk for the subjectpool to the party subject to the capital reserve requirements; andassigning a remaining portion of the credit risk to a second party. 5.The method of claim 4, wherein the credit risk rating includes aplurality of rating categories, and wherein assigning a portion of thecredit risk for the subject pool further comprises: retaining a portionof credit risk on a category by category basis for each of a pluralityof rating categories; and capping the portion of retained credit risk toa maximum level for each of the plurality of rating categories.
 6. Asystem comprising: a processor for executing computer-readableinstructions; and a non-transitory computer-readable storage mediumstoring the program instructions, the program instructions, whenexecuted by the processor, performing a process to reduce capitalrequired to be held in connection with a subject pool of loans, theprocess comprising: assisting in obtaining a credit risk rating of theloans in the subject pool; allocating credit risk for the subject poolamong a plurality of parties, based on the credit risk rating and a lossperformance of the subject pool in comparison to a reference pool ofloans having similar characteristics to the loans in the subject pool;applying capital reserve requirements to the subject pool based on thecredit risk rating and the credit risk allocated to a party subject tothe capital reserve requirements for loans in the subject pool; holdingan amount of capital against the subject pool based on application ofthe capital reserve requirements.
 7. The system of claim 6, whereinallocating credit risk for the subject pool further comprises: capping aportion of the credit risk to a maximum level for the party subject tothe capital reserve requirements from the plurality of parties.
 8. Thesystem of claim 7, wherein the maximum level is a percentage of thesubject pool value.
 9. The system of claim 6, wherein allocating creditrisk for the subject pool comprises: assigning a portion of the creditrisk for the subject pool to the party subject to the capital reserverequirements; and assigning a remaining portion of the credit risk to asecond party.
 10. The system of claim 9, wherein the credit risk ratingincludes a plurality of rating categories, and wherein assigning aportion of credit risk for the subject pool further comprises: assigningthe portion of credit risk on a category by category basis for each of aplurality of rating categories; and capping the portion of assignedcredit risk to a maximum level for each of the plurality of ratingcategories.
 11. A non-transitory computer-readable medium comprisingcomputer-executable instructions for reducing capital required to beheld in connection with a subject pool of loans by: accessing dataregarding a credit risk rating of the loans in the subject pool;accessing data regarding allocating credit risk for the subject poolamong a plurality of parties, based on the credit risk rating and a lossperformance of the subject pool in comparison to a reference pool ofloans having similar characteristics to the loans in the subject pool;applying capital reserve requirements to the subject pool based on thecredit risk rating and the credit risk allocated to a party subject tothe capital reserve requirements for loans in the subject pool;presenting an indication of the amount of capital held in connectionwith the subject pool based on application of the capital reserverequirements.
 12. The non-transitory computer-readable medium of claim11, wherein accessing data regarding allocating credit risk for thesubject pool further comprises: for the party subject to the capitalreserve requirements from the plurality of parties, accessing dataregarding capping the specified party's a portion of the credit riskallocated to the party to a maximum level.
 13. The non-transitorycomputer-readable medium of claim 12, wherein the maximum level is apercentage of the subject pool value.
 14. The non-transitorycomputer-readable medium of claim 11, wherein accessing data regardingallocating credit risk for the subject pool comprises: accessing dataregarding assigning a portion of the credit risk for the subject pool tothe party subject to the capital reserve requirements; and accessingdata regarding assigning a remaining portion of the credit risk to asecond party.
 15. The non-transitory computer-readable medium of claim14, wherein the credit risk rating includes a plurality of ratingcategories, and wherein an assigned portion of the credit risk applieson a category by category basis for each of a plurality of ratingcategories, and the assigned portion of credit risk is capped to amaximum level for each of the plurality of rating categories.
 16. Amethod, implemented using a data processing system, for reducing capitalrequired to be held in connection with a subject pool of assetscomprising: obtaining, as an input to the data processing system, a riskrating of the assets in the subject pool; retaining, by a party subjectto capital reserve requirements for loans in the subject pool among aplurality of parties, a portion of risk for the subject pool, based onthe risk rating and a loss performance of the subject pool in comparisonto a reference pool of loans having similar characteristics to the loansin the subject pool; applying, using the data processing system, thecapital reserve requirements to the subject pool based on the riskrating and the portion of risk retained by the party subject to thecapital reserve requirements for loans in the subject pool; determining,using the data processing system, an amount of capital to hold inreserve in connection with the subject pool based on application of thecapital reserve requirements; and presenting the determined amount ofcapital to the party.
 17. A system comprising: a processor for executingcomputer-readable instructions; and a non-transitory computer-readablestorage medium storing the program instructions, the programinstructions, when executed by the processor, performing a process toreduce capital required to be held in connection with a subject pool ofloans, the process comprising: obtaining a risk rating of the assets inthe subject pool; retaining, by a party subject to capital reserverequirements for loans in the subject pool among a plurality of parties,a portion of risk for the subject pool, based on the risk rating and aloss performance of the subject pool in comparison to a reference poolof loans having similar characteristics to the loans in the subjectpool; applying the capital reserve requirements to the subject poolbased on the risk rating and the portion of risk retained by the partysubject to the capital reserve requirements for loans in the subjectpool; determining an amount of capital to hold in reserve in connectionwith the subject pool based on application of the capital reserverequirements; and presenting the determined amount of capital.